Life insurance is complex and confusing. But it is a critical component of the protection piece of your 5 Pillars of Personal Finance. The cheapest and most basic form of life insurance is term insurance. However, term insurance comes with a big downside, it expires. This is also the reason it is low cost; it only covers you for a set period of time. Luckily, there is a little known and discussed option available on most term policies that allows you to extend that coverage for life, the conversion rider.
Term conversion riders allow you to convert your term policy to a permanent policy at any point covered in the rider. As you age and your personal financial situation evolves, you may decide that converting to a permanent policy is right for you.
Term conversion riders are often not discussed and many people have this option but are unaware of it.
Therefore, convertible term insurance is one of the biggest kept secrets in insurance.
Term conversion riders often come standard on the term policy if you purchased your term from a big, known insurer. Term products that have conversion privileges standard are sometimes referred to as ‘convertible term’. If you have a term policy, you should read your policy packet or contact your provider to see if it comes with conversion privileges
How does a term conversion rider work and is it right for you?
What Is A Term Conversion Rider?
First, a ‘rider’ is just an add-on feature to the main policy. Hence the name, as it is ‘riding on’ the main policy. There are dozens of different types of riders out there. They can come standard, can be added at no cost, or can be added for an additional charge.
A term conversion rider allows you to convert your term policy into a permanent policy. This allows you to get lifetime permanent coverage by the same insurance company.
Many times big, known insurers have this rider come standard on their policies and at no additional cost. When it comes standard, it is sometimes called ‘convertible term’. If you already have a term policy you may have this rider and not even know it. You can review your policy documents or contact your insurance company to see.
When you convert from a term policy to a permanent policy, you retain the same underwriting class and face amount. Even if your health has significantly deteriorated, you can get a permanent policy and be in the better risk class until you die. (Better risk class means lower cost to you.)
Additionally, most conversions allow you to elect any permanent product that is currently being offered by the insurer. Although the industry is starting to restrict what products you can convert to on newer term policy.
Term conversion riders allow you to extend your coverage beyond the level-pay period on your term contract. If you purchased a policy decades ago but you decide you want your coverage for longer, converting your term is an easy way to get a permanent policy without having to go back through underwriting. Not a bad deal!
Simplified Online Insurance Products Often Don’t Have Conversion Privileges
Many personal finance blogs & gurus recommend getting your term policies through online brokers using a simplified underwriting process. This can be a convenient way to get life insurance coverage. But beware that many of these companies do not offer conversion privileges on their policy.
The lack of a conversion option is one of the ways these companies keep their prices lower. Conversion is a big cost to the insurance company. When someone converts, the company is unable to review the policyholder’s health. They need to allow you to take the permanent policy at the same underwriting class.
For example, you purchased a term policy when you were 25 and healthy, but you are 44 and in significantly worse health now. You would get the privilege of paying premiums at a lower price since you would convert into the healthiest underwriting class. This means the insurance company would be undercharging you relative to your risk of dying. When the insurance company undercharges you, that is a positive for you.
The lack of conversion isn’t a nefarious act by these online insurance providers. Many of them do not even offer a permanent option. So they have no product for you to convert into to.
You should be aware that choosing a convenient online insurance provider for your term purchase does come with trade-offs.
When Should You Convert Your Term Insurance?
The decision to convert your term policy or let it expire is one that is specific to you. You should review your financial needs and situation.
Term products are often purchased for a purpose in mind. Typically people buy a term policy for coverage until a child is grown or a mortgage is paid off.
For example, if you have a new child and you want to make sure your child is cared for. You could buy a 20-year term policy. A 20-year term policy will provide protection through your child being college age. Additionally, in 20 years you will have built up savings and retirement funds. You may have enough saved to cover any future needs of your dependents, meaning insurance coverage may not be necessary.
However, things don’t always go as planned, and there are times that converting to a permanent policy makes sense. If your haven’t been able to hit your savings goals, you may want to convert to a permanent policy to ensure there is money left to your loved ones. Additionally, insurance can be a tax-efficient vehicle to pass wealth on as part of your estate plan. Permanent insurance is often used for this estate planning need.
How Does A Term Conversion Work?
Each policy and every insurance company has its own rules around conversions. Typically the easiest way to find out about your specific policy is to contact the company or review your policy documents. However, here are some items to consider when thinking about conversions.
Conversion Features to Consider:
- Conversion Period – Each policy will have a pre-defined period where you can convert. Some common examples of conversion periods include:
- Convert before the end of your level-pay period. The level-pay period is synonymous to the length of your term loan. So a 20-year term will allow conversion for 20 years.
- Many policies do have a ‘post-level term’ period. This allows you to continue to purchase 1 year renewable term after the maturity of your policy. Albeit at increasingly larger premiums each year.
- Convert before a certain age. Often there is an age limit to convert where even if your policy hasn’t matured, you can no longer convert to a permanent policy. This is typically around 70-80 years old.
- Convert by a specific duration. Some insurers only let you convert during the first X years of the policy. So even if you have a 30-year term, you may only be able to convert during the first 10 years you own the policy
- Convert before the end of your level-pay period. The level-pay period is synonymous to the length of your term loan. So a 20-year term will allow conversion for 20 years.
- Available permanent products – most insurers allow you to convert to any permanent product they currently offer. However, the insurance industry is starting to limit conversions to only specific products.
- Partial conversions – most insurers give you the option to convert up to the face amount on your term policy. If you have $250,000 of term coverage, but only want enough permanent coverage to pay for funeral expenses, you may be able to convert to a $20,000 permanent policy. This feature can be used to keep your premium payments the same.
The longer you have owned a term policy, the more generous your conversion feature likely is.
Cost of Converting a Term Insurance Policy to Permanent Insurance
Typically there is no cost to convert a term policy to a permanent policy. However, permanent insurance will cost 5-15x more than term insurance for the same age. Also, since you will be converting at an older age than when you purchased your term policy, the price will be higher due to you being older. The higher your mortality rate (the probability of you dying) the more expensive your policy. And as you age, your mortality rate increases.
The higher premiums on a permanent policy can be partially offset from keeping the underwriting class on the term policy. Since most people become less healthy as they age, you likely have a better health rating on your term policy than if you were to go out and buy a new permanent policy.
Also, higher interest rates tend to be a positive for insurance companies which allow them to offer lower premiums. Therefore, if market conditions have changed the premium on a permanent policy may be relatively low.
If you are thinking about converting, your insurance agent will need to run an illustration and tell you the premiums you will pay on the new policy. So you will get a chance to preview what the cost to you will be before you decide.
Alternatives to Term Conversion
If term conversion isn’t right for you, there are some alternative options available to extend coverage.
- Buy More Term – You could always buy a new term policy with a coverage period that fits your new needs. A new term policy will be cheaper than a permanent policy unless your health has significantly gotten worse.
- You can keep the original term product till it matures or let it lapse so you no longer need to pay for the old policy. However, most term products can not offer coverage past 90-95 years old. So this won’t guarantee lifetime coverage if you live a long time.
- Set up a Term Ladder – A term life insurance ladder is when you purchase multiple smaller term policies that mature on different dates. By stacking term policies you have varying coverage amounts over your life. This does require some up front planning though.
- Post-level term / renewable term – Many term products give you the option to purchase 1-year renewable term policies after the pre-determined coverage. The post-level term coverage starts at a much higher cost. Each year your premium will increase significantly or your coverage will automatically decrease.
- Self Insurance – self insurance is when you have saved up a sufficient amount of wealth that your dependents are covered from your estate.
Each one of these alternatives may be an acceptable replacement to converting your policy.
The Final Word – Term Conversion Riders
Term conversion riders give you immense flexibility for your coverage. Despite all the positives, term convertibility is often over-looked and unknown. Since the main complaint about term insurance is that the coverage expires, having a conversion rider helps to alleviate that concern.
If you are tackling your personal finances, term insurance with conversion is something you probably want to look into.
Most term policies are purchased while people are relatively young and on a tighter budget. When you become more established, you may be able to afford a more expensive permanent policy and elect to convert.
All insurance decisions are highly individualized, so make sure any conversion choice fits into your personal financial plan.
Frequently Asked Questions – Term Conversion Riders
A rider is an additional feature that is added-on to the main policy. The feature is ‘riding’ on the main policy, hence the term rider. Some riders can be added free of charge and others come with an additional fee. There are many types of riders. Some common riders are higher payouts if you die by accident, the ability to access your death benefit to pay for care while you are alive if you become disabled, and the ability to convert your term policy to a permanent policy.
A term conversion rider allows you to convert your term policy into a permanent policy offered by the insurance company. When you elect to convert, you get to keep the same underwriting class and face amount as you had on your term policy. This means that even if your health has deteriorated, you get to pay lower premiums as if you were in a healthier underwriting class.
There are occasions that an insured will improve their health after purchasing a term product. Maybe you lost significant weight and improved your blood pressure and lipid profile after taking up exercise (good job). Most conversion riders give you the option to go through underwriting again so you can improve your risk class.
This means that a conversion rider prevents you from getting a worse rating (higher premium) but leaves the option for getting a better health rating (lower premiums).
There typically is not a material cost to conversion. But permanent policies tend to cost 5-15x more than a term policy for the same issue age. Additionally, the older you are, the higher premium you will pay on a policy since you have a higher expected mortality.
If you purchased a term product at 25 years old and you convert at 45 years old, you will not only be paying the higher cost of permanent insurance, but paying a higher premium due to being 20 years older.
However, when you convert you get to keep your underwriting class. Therefore, if your health has deteriorated you will likely get a lower premium on your converted policy than you would if you went out to purchase a brand new permanent policy at a worse health class.
Yes. There are 4 common alternatives to term conversion that can extend your coverage.
1) Buying more term insurance with a maturity date that fits your new needs
2) Laddering smaller term policies so you have coverage that changes as your needs change
3) Post-level term annual renewable 1-year term allows you to pay increasing premiums to keep extending your coverage
4) Self-insurance is when you save up enough that you have ample wealth to leave to your dependents
However, all term products have a max coverage age (often 90-95 years old) so a permanent policy is one of the only options for having lifetime coverage.
2 thoughts on “Conversion Riders On Term Insurance – Insider Secrets”
Comments are closed.